Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Ahlstrom-Munksjö Oyj (HEL:AM1) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is Ahlstrom-Munksjö Oyj's Debt?
As you can see below, Ahlstrom-Munksjö Oyj had €1.08b of debt at June 2020, down from €1.19b a year prior. On the flip side, it has €259.6m in cash leading to net debt of about €824.0m.
How Strong Is Ahlstrom-Munksjö Oyj's Balance Sheet?
We can see from the most recent balance sheet that Ahlstrom-Munksjö Oyj had liabilities of €850.7m falling due within a year, and liabilities of €1.19b due beyond that. On the other hand, it had cash of €259.6m and €309.4m worth of receivables due within a year. So its liabilities total €1.5b more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of €1.59b, so it does suggest shareholders should keep an eye on Ahlstrom-Munksjö Oyj's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Ahlstrom-Munksjö Oyj has a debt to EBITDA ratio of 2.8 and its EBIT covered its interest expense 2.9 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Looking on the bright side, Ahlstrom-Munksjö Oyj boosted its EBIT by a silky 32% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Ahlstrom-Munksjö Oyj's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Ahlstrom-Munksjö Oyj's free cash flow amounted to 29% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Ahlstrom-Munksjö Oyj's interest cover and level of total liabilities definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. When we consider all the factors discussed, it seems to us that Ahlstrom-Munksjö Oyj is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - Ahlstrom-Munksjö Oyj has 3 warning signs (and 1 which is a bit concerning) we think you should know about.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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